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Analyst Interview: David Song on Fed Policy, US Dollar Outlook

Analyst Interview: David Song on Fed Policy, US Dollar Outlook

2012-03-20 18:30:00
David Song, Strategist
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• What would you say is the major global theme in currency markets at this time? What do you feel is driving major currency trader sentiment?

With the headline-driven market, the major fundamental theme driving currency prices is the global threat of the sovereign debt crisis. World policy makers continue to strike a cautious tone amid the ongoing turmoil in the euro-area, and the risk for contagion will continue drag on investor confidence as European officials struggle to meet on common ground. As the governments operating under the single currency become increasingly reliant on monetary support, we are likely to see the European Central Bank carry out its easing cycle throughout 2012, and the Governing Council may have little choice but to push the benchmark interest rate below 1.00% as the region continues to face a risk for a prolonged recession.

• The Federal Reserve looks increasingly unlikely to inject QE3 into the economy any time soon. Do you agree with this, and if so, could this be considered bullish for the USD?

In light of the more robust recovery in the U.S., the Fed certainly has limited scope to expand its balance sheet further. As we expect the FOMC to bring its easing cycle to an end in 2012, the shift in the policy outlook instills a bullish forecast for the U.S dollar, and we should see the committee continue to soften its dovish tone as stronger growth paired with sticky prices raises the risk for inflation. Indeed, market participants see the Fed starting to normalize monetary policy over the next 12-months amid the shift in the policy outlook, and the rise in interest rate expectations should strengthen the dollar further as the central bank prepares to wind down its balance sheet while dismissing the zero-interest rate policy (ZIRP).

• As more bailouts are most likely necessary for further euro zone countries, do you feel that the EUR/USD inevitably will trend lower? What is your outlook or forecast for the EUR/USD?

We maintain a bearish outlook for the EURUSD as the fundamental outlook for the euro-area remains bleak, and the pair looks poised for a major move to the downside as it appears to be carving a head-and-shoulders top in March. In turn, we expect to see fresh yearly lows in the EURUSD, and the pair may ultimately give back the rebound from back in 2010 as European policy makers struggle to restore investor confidence. As the EU maintains a reactionary approach in addressing the debt crisis, the efforts could arguably be too little too late, and the implementation of the crisis-fighting measures are likely to come under scrutiny as the group now looks to promote growth.

• The USDJPY has surged to its highest level in almost a year, can you comment on this currency pair and do you feel that the forecasts to go higher are correct?

The recent surge in the USDJPY comes as the Federal Reserve talks down speculation for QE3, and the rise in interest rate expectations should carry the dollar-yen higher as the Bank of Japan continues to embark on its easing cycle. As the BoJ pledges to meet the 1% target for inflation, it looks as though the central bank will further expand its asset purchases over the coming months, and the disparity in monetary policy will heavily influence the exchange rate as these developing fundamental themes take shape.

• There was a lot of talk last week about US treasuries prices increasing, can you explain how this can affect the US dollar and the currency markets?

As market participants speculate the Federal Reserve to normalize monetary policy ahead of the 2014 pledge, expectations for higher interest rates have sparked demands for U.S treasuries, but this development will have the greatest impact on the USDJPY as the BoJ looks to maintain its zero interest rate policy for a prolonged period of time. Indeed, the shift in central bank rhetoric will heavily influence the USD, and we should see the correlation between risk sentiment and the dollar continue to decouple as interest rates are set to go higher.

--- Answers provided by David Song, Currency Analyst for DailyFX.com for an interview with CountingPips.com

To contact David, e-mail dsong@dailyfx.com. Follow me on Twitter at @DavidJSong

To be added to David's e-mail distribution list, send an e-mail with subject line "Distribution List" to dsong@dailyfx.com.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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